So, your franchise agreement has an airtight arbitration provision…right? It probably says that if any disputes arise out of your franchise agreement, then they must be arbitrated (rather than litigated). But what happens when creative plaintiff’s counsel argues that the arbitration provision itself is unenforceable? Does your arbitration provision require that question to be arbitrated?
A recent California case provides a unique side by side comparison of two arbitration provisions: one that passed the drafting challenge, and one that didn’t, requiring the franchisor to litigate rather than arbitrate the enforceability of its arbitration provision.
Franchisor Dickey’s Barbeque Restaurants, Inc. (“Dickey’s”) was sued by franchisees alleging fraud and violations of California’s Franchise Investment Law and other laws. Meadows v. Dickey’s Barbecue Restaurants Inc., No. 15-cv-02139-JST (N.D. Cal. Nov. 12, 2015). The franchisees also asked the court to declare that the arbitration provisions in their franchise agreements were unenforceable (thus justifying litigation).
The case involved two different franchise agreements, with two different arbitration provisions.
The first provision (which we’ll call the “Hammer Provision”) broadly required arbitration of disputes “arising out of or relating to” the franchise agreement.
The second provision (the “Scalpel Provision”) went into greater detail, encompassing disputes
arising between the parties in connection with, or arising from, or with respect to (1) any provision of [the franchise agreement] . . . ; (2) the relationship of the parties; (3) the validity of [the franchise agreement] . . . or any provision thereof ….
Under federal law, courts apply a “clear and unmistakable” standard when deciding whether “gateway” questions of arbitrability should be decided by an arbitrator or by a court. In other words, if parties want an arbitrator to decide whether a dispute should be arbitrated, the contract must indicate this intention “clearly and unmistakably.” If the contract doesn’t meet this threshold, the court – and not the arbitrator – will decide that primary question.
Of course, courts will look to the language of the contract to determine whether the parties’ intent to delegate is “clear and unmistakable.” But they will also consider the parties themselves. If the court determines that one party is “unsophisticated” it may be more difficult to show clear and unmistakable intent. For example, the rules of the American Arbitration Association (“AAA”) state that an arbitrator has the power to rule on his or her own jurisdiction to hear a case. Many courts have found that incorporating the AAA rules into an arbitration provision is clear and unmistakable evidence that the parties intended to arbitrate arbitrability. However, a court may be reluctant to assume that an unsophisticated party knows the AAA rules. It might require additional evidence of the parties’ clear and unmistakable intent.
The sophistication question is especially important in the franchise context. Courts may generally assume franchisors are sophisticated and franchisees are not.
“California courts have long recognized that franchise agreements have some characteristics of contracts of adhesion because of the ‘vastly superior bargaining strength’ of the franchisor.”
Nagrampa v. MailCoups, 469 F.3d 1257, 1282 (9th Cir. 2006).
Emerging franchisors especially may not feel that they’re in a “vastly superior” bargaining position to their potential franchisees. But will a court agree? The best strategy is to assume a court will view the franchisee as unsophisticated and draft accordingly – clearly and unmistakably.
The Dickey’s court determined that the Scalpel Provision showed the parties’ clear and unmistakable intent to let an arbitrator decide arbitrability. It specifically noted that the provision required arbitration of disputes with respect to “the validity of [the franchise agreement] . . . or any provision thereof . . . .”
The Hammer Provision, despite its breadth, did not fare as well. The court noted that the broad language “might” encompass the threshold issue of arbitrability. But “might” is not clear and unmistakable. This was partly a drafting issue, but also because the franchisees were unsophisticated parties. Although the Hammer Provision incorporated the AAA rules, the court would not impute knowledge of the AAA rules to the franchisees.
Therefore, the court determined that it, and not an arbitrator, was the appropriate decision maker with respect to the Hammer Provision. Ultimately, the court decided that the provision was enforceable and granted Dickey’s motion to compel arbitration. But it was a day in court (including associated costs) that could have been avoided.
Thorough drafting can help close the gaps for creative plaintiff’s counsel to exploit. When “clear and unmistakable” is the standard, broad language alone may not suffice – both a hammer and scalpel may be necessary to craft an airtight arbitration provision. In the franchise context, clear drafting is especially important. Courts may hold franchise agreements to a higher standard of clarity if they find that franchisees are unsophisticated parties or that a franchisor is in a superior bargaining position compared to its franchisees.